Finance Commission’s new problem: Separate defence fund

“State X is getting a better deal than my state Y” is perhaps the most common grouse that one hears while discussing the Finance Commission. This lament misses out on something a lot more significant  -- the distribution of fiscal resources between the Union government on one side and all states put together on the other. In fact, it is this vertical devolution question which should concern all states as the Fifteenth Finance Commission (FFC) approaches the November 30 submission deadline for its much-awaited report.

The original terms of references for the FFC themselves were contentious. Based on the wrong assumption that the last Finance Commission was overly generous towards the states, the terms were designed to nudge the FFC towards reducing the tax devolution to the states in order to meet the requirements of central schemes of the Union government. If that wasn’t enough, an additional term of reference has now been recommended by the Union cabinet tasking the FFC “to ensure an assured allocation of resources towards defence and internal security imperatives.”

Allocating adequate, secure and non-lapsable funds for the security of India is indeed an urgent priority. There can be no quarrel about that objective. But the move to provide for these funds through the FFC is problematic for several important reasons.

For a start, there’s absolutely nothing that stops a Union government even today from allocating more for defence. This function is solely in the Union government’s domain and perhaps its most important responsibility. It is the first item under the Union List in the constitution’s seventh schedule. And yet, the inability of successive governments to provide funds for this function should make us question  -- to what use are the existing revenues and loans being put to? This demand then for a separate defence fund from the FFC is like an airline demanding an additional advance charge from you for not crashing the plane.

Quite a few avenues are available with the Union government to make space for funding something as important as defence expenditure.

Start with a reprioritisation within the defence ministry itself, from manpower to firepower. In FY 2019–20, GoI plans to spend ₹1.12 lakh crore on pensions and retirement benefits alone. This means out of every rupee spent on defence in 2019–20, 23 paise will be allocated towards pension payments. In comparison, only 22 paise will be allocated for capital outlay on defence services. Moreover, the pension liabilities will keep increasing unsustainably because they are indexed to future wages. Reducing this total pension outlay by retaining the retiring soldiers in the National Security System is one way to finance the capital outlay needs of defence.

The next option for the Union government is to end some centrally sponsored and central sector schemes. Currently totalling 122, many of these schemes fall squarely in the domain of state governments. It would be better if these sundry schemes are replaced by additional general-purpose transfers to the state governments, who can then choose to spend based on their own priorities.

Then there's the case of wasteful expenditure. It is unconscionable to ask FFC to create a separate defence fund while the government keeps injecting funds into companies such as Air India that cost the government a loss of ₹15 crore per day.

The second problem with this amendment is that carving out a fund for one purpose from the total taxable pool will set a dangerous precedent for successive Union governments to seek their own separate funds for other functions in the Union List such as railways, national highways, shipping etc. The burden of this extravagance will be borne by the state governments as tax devolution to them will come under pressure.

The third problem is its impact on the character of the Finance Commission. The Finance Commission today enjoys legitimacy as an impartial arbitrator of the interests between the Union and state governments. If the Union government manages to get FFC to recommend special funds for Union’s functions, state governments will lose faith in what has hitherto been a rare institutional success in Indian democracy.

Not all is lost though. The FFC would be well within its powers to ignore the demand of creation of a separate defence fund. Being a constitutional body appointed by the President of India, it can — and must—ignore attempts that violate the federal spirit of the Indian constitution.

(Pranay Kotasthane is a Fellow at the Takshashila Institution, a centre for research and education in public policy)

(The views expressed above are the author’s own. They do not necessarily reflect the views of DH)